Firing on all cylinders

As global output slack diminishes, global inflation will start to pick up

US economy picked up pace in 2017

Europe has been the standout performer

Keep an eye out for Japan in 2018

Chinese growth: quality over quantity

Global growth expected to improve further in 2018

Our global growth outlook for 2018 is strong. The broad-based, synchronised upswing that began a year ago shows no signs of easing up, with above-trend growth expected to extend from the major G7 economies to the emerging markets in 2018. That should see global growth approach 4 per cent, the strongest since 2011 and consistent with a continued reduction in global slack, increased inflationary pressures and a geographical broadening in the removal of extremely accommodative monetary policy.

As 2017 draws to a close, it is likely that global growth will finish the year well ahead of where consensus expectations were twelve months ago. This largely reflects much better growth than anticipated in the Eurozone, but also better outturns in Japan and China. It is also in spite of the US failing to deliver on President Trump’s much-vaunted tax reform plans until the end of 2017. Furthermore, it would also be the first time since 2010 that global growth has surprised on the upside, with many forecasters, such as the IMF, raising their projections for 2018 (Figure 1).

We have also raised our expectations for 2018, reflecting positive global consumer and business sentiment, limited private sector balance sheet risks and still easy financial conditions. We think the main upside risk is likely to come from the US (on greater-than-expected fiscal stimulus), and the main downside risk likely from a more rapid slowing in Chinese growth.

An expected steady increase in inflation suggests further removal of monetary policy accommodation

We expect global consumer price inflation will be little-changed in 2018 compared to 2017, with a modest rise in advanced economies offset by a similarly modest decline in emerging markets (Figure 2).

The rise in advanced economy inflation reflects a similar increase of around ¼ per cent across the major economies over the course of next year, with the United Kingdom the only exception. Those increases reflect the lagged effect of the reduction, and in some cases, elimination of spare capacity, that has seen wage growth rise steadily. A further steady rise is expected in 2018, with that imparting further modest upward pressure on inflation.

In some economies, such as the US, the impetus for a somewhat larger increase in inflation may come from the potential non-linear effects of an extremely tight labour market. But structural headwinds make it unlikely for inflation to spike higher. Our growth and inflation outlook is consistent with a gradual removal of policy accommodation, with the Federal Reserve leading the way with further rate hikes, but with other central banks likely to move towards tighter, rather than looser policy.

In the Eurozone we expect asset purchases to end in September and in Japan we see the potential for the Bank of Japan (BoJ) to review its policy of yield curve control (YCC) if core inflation rises above 1 per cent. The outlook for the Bank of England is highly dependent on developments in the Brexit negotiations next year, which have the potential to move policy in either direction. Elsewhere, there is potential for interest rate rises in Canada, Australia, New Zealand, Sweden and Norway in 2018.

Peak monetary stimulus is behind us

Over the course of 2017 above-trend growth across the major developed economies helped unemployment rates decline further. As a result, unemployment rates in some economies, such as the US, UK and Japan are now below the levels seen prior to the global financial crisis. Even allowing for the possibility that the equilibrium rate of unemployment may have fallen since 2007, these economies are likely to be very near to full employment (Figure 3). Other economies, such as the Eurozone, are further behind in their expansionary phase, and continue to have a reasonable degree of spare capacity.

However, with a similar rate of above-trend growth expected next year, the Eurozone is likely to have relatively little spare capacity by the end of 2018. As the degree of spare capacity has been eroded, central banks have begun to embark on policy normalisation. The US Federal Reserve is likely to have raised rates five times in this cycle by the end of 2017. Looking ahead, the market is currently pricing little more than one more hike in the US in 2019 and beyond, compared to another six increases currently expected by the Fed (Figure 4).

We think the market is under-pricing the risk of further rate hikes over the coming year and beyond. Other markets look more fairly priced in terms of short-term rates, with little prospect of the European Central Bank (ECB) or the BoJ raising the short-term policy rate in 2018.

Global conditions supportive of risk assets, but duration more challenged

Expectations of stronger global growth and modestly higher inflation in 2018 provide the backdrop for a positive risk environment, just as they did in 2017 (Figure 5). Moreover, with the improvement in the global economy and the peak of monetary policy accommodation likely behind us, we would expect asset markets to be driven more by the underlying fundamentals than at any point in the past decade.

In terms of equity markets, that should mean a focus on the earnings outlook, valuations and sector allocations is likely to be increasingly important. The correlation between stocks within equity indices declined sharply in 2017, consistent with company fundamentals driving returns, rather than external risk factors. That increased dispersion of returns has also been a contributory factor to the decline in overall equity index volatility.

Looking to 2018, we think that among the main regions, emerging market equities should benefit most from the improving global growth outlook, while also standing to gain from relatively lower valuations.

Among developed markets, we expect Eurozone equities to be supported by continued above-trend growth and receding political concerns. We also feel that Japanese equities present a good opportunity in 2018, with the potential for strong corporate profitability and a potential sea-change in corporate and household inflation expectations.

Global bond yields expected to rise, making duration a more challenging environment in 2018

While risk assets should be supported by economic growth, risk-free assets are more challenged. Arguably the most challenged is Eurozone government debt, where yields continue to be suppressed by ECB asset purchases. However, with a likely end to QE in September, we expect pressure on yields to start rising by the middle of 2018.

Japanese government bonds are even more expensive, and could also be subject to a sell-off in 2018 if inflation rises above 1 per cent and the BoJ adjusts their target on YCC. If longer-term yields in these markets were to rise, then the pressure on global term premia would also increase, at a time when we expect the Federal Reserve to continue raising rates and reduce their balance sheet.

Indeed, the liquidity and credit support globally from central bank balance sheets is likely to fall materially over the course of 2018 (Figure 6). That could be the catalyst for a normalisation interm premia and a more sustained rise in yields. However, there are likely to be some countervailing forces on yields, such as the demand for increased duration from Asia.

Strong global growth should see corporate defaults decline further and support high yield credit

Investment grade corporate credit in both the US and Europe is also likely to be challenged in 2018 given the yield spread tightening seen over the past year and our views on the risk to duration.

In Europe there is the added risk associated with the expected end of ECB purchases later in 2018. High yield credit is relatively more attractive given the potential for some further narrowing in spreads and the low probability of a material default cycle starting in 2018. Indeed, default rates are expected to decline further over the next 12 months.

The prospects for emerging market (EM) debt are also encouraging, with improved fundamentals and attractive valuations more than compensating for a rise in US rates. That said, recent months have seen heightened idiosyncratic risks, highlighting the potential for greater volatility across the EM debt spectrum, particularly with numerous elections taking place in 2018. A more cautious stance is warranted on EM hard currency (dollar-denominated) debt, where valuations look more stretched.

Under-valued currencies should benefit from global reflation

Finally, we think that global reflation will continue to favour currencies that are under-valued on a longer-term basis. That means the US dollar's peak is likely behind us, absent a more aggressive move by the Federal Reserve to tighten policy.

The main beneficiary of the benign global environment ought to be emerging market currencies, although as with emerging market debt, idiosyncratic factors will dominate in some instances.

We see the better performance as likely to be in India and Indonesia, with South Africa and Turkey more challenged.

We expect the major G10 currencies to be relatively range-bound in 2018, with the euro likely to perform a little better on stronger domestic factors. Sterling remains vulnerable to Brexit negotiations, but could equally outperform if it looks likely there will be a long transition period agreed.

Michael Grady

Senior Economist & Strategist

Main Responsibilities

Michael is responsible for monitoring and analysing macroeconomic data, markets and policy developments across a range of countries. His analysis forms a key input into the investment process across the business. Alongside that, he takes a leading role in investment strategy for our AIMS range of funds.

Experience and qualification

Prior to joining Aviva Investors in 2015, Michael was Senior Economist at COMAC Capital Llp, a global-macro hedge fund, where he was responsible for the fundamental analysis used to inform the investment process. That followed a decade at the Bank of England, in a variety of roles. He began his career at the Australian Treasury.

Stewart Robertson

Senior Economist (UK and Europe)

Main Responsibilities

As part of the Strategy Team, he is responsible for economic research and analysis of the UK and main European markets.

Experience and qualification

Prior to joining Aviva Investors, Stewart worked for Lombard Street Research, where he specialised as a UK economist. He also held positions at Coopers & Lybrand and Unilever plc. Stewart began his career as an economist in 1987, before joining financial markets in 1993.
Stewart holds a BA (Hons) in economics from Liverpool University and an MSc in economics from the London School of Economics and Political Science.

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (Aviva Investors) as at 1 December 2017. Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates.

Nothing in this document is intended to or should be construed as advice or recommendations of any nature. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

In the UK & Europe this document has been prepared and issued by Aviva Investors Global Services Limited, registered in England No.1151805. Registered Office: St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Telephone calls to Aviva Investors may be recorded for training or monitoring purposes.

In Singapore, this document is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited for distribution to institutional investors only. Please note that Aviva Investors Asia Pte. Limited does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia Pte. Limited in respect of any matters arising from, or in connection with, this document. Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and is an Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.

In Australia, this document is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd for distribution to wholesale investors only. Please note that Aviva Investors Pacific Pty Ltd does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Pacific Pty Ltd in respect of any matters arising from, or in connection with, this document. Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000

Download Aviva Investors House View 2018 Outlook

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as of December 18, 2017. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results.

The name “Aviva Investors” as used in this presentation refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva Investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

For Use in Canada

Aviva Investors Canada, Inc (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager.

For Use in the United States

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). In performing its services, AIA utilizes the services of investment professionals of affiliated investment advisory firms who are best positioned to provide the expertise required to manage a particular strategy or product. In keeping with applicable regulatory guidance, each such affiliate entered into a Memorandum of Understanding (“MOU”) with AIA pursuant to which such affiliate is considered a “Participating Affiliate” of AIA as that term is used in relief granted by the staff of the Securities and Exchange Commission allowing US registered investment advisers to use portfolio management and trading resources of advisory affiliates subject to the supervision of a registered adviser. Investment professionals from AIA’s Participating Affiliates render portfolio management, research or trading services to clients of AIA. Investment professionals from the Participating Affiliate also render substantially similar portfolio management research or trading services to clients of advisory affiliates which may result in performance better or worse than presented herein. This means that the employees of the Participating Affiliate who are involved in the management of strategies and other products offered to US investors are supervised by AIA.

AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: